3/09/2006

price war: does anyone benefit?

When two companies compete and in turn both lower their prices as with cable and DSL does anyone benefit? You would think the consumer benefits due to the lower prices but this is not always true. When two companies compete and end up in a price war, generally both companies lower value along with price. In the end the companies lose profit and the customer loses value.
Posted by Will

6 comments:

Seth said...

When two companies engage in a price war the quality of the products and services provided are likely to be cut along with price. That doesn’t necessarily mean customers are worse off. In an inefficient market where customers are not well informed the value to them may decrease but on the other hand the fact that they are looking of the lowest price shows that the quality of the products and services is not so important. With good information customers is better off in a price war because they don’t have to pay for higher quality than they want.

Ole said...

In a price war, I would agree that customers may indeed get the quality of product they want for the price they are willing to pay. Sure there is always better quality somewhere else for a higher price. However, the companies that are involved in the price war are targeting a specific type of customer. Sure some of those customers may indeed get a lower quality product, but in my opinion, I don’t think they care. The customers that do care, will not buy the product.

Boris said...

I care! You can't tell me you'd rather pay $30 for 4 local channels and 73 game show / celebrity gossip / design your house for $3 channels, than pay $40 for 30 good channels! I think these price wars definitely hurt consumers sometimes.

Dr. Tufte said...

Will: Make sure I give you credit for this!

-1 on Seth's comment for grammatical errors.

In reality, it isn't likely to turn out this way. In classes, we talk about firms competing by changing their prices this way, but the same argument will follow for competition through markups. Eventually they will be driven to zero.

It is true, however, that one way to compete is to reduce quality. But, what will happen is that firms will compete along more than one dimension (say, quality and price). Ultimately, they will still ring out anything that permits abnormal profits. It is even possible for them to compete by raising quality.

Boris: I feel your pain ;) but you are bringing up two somewhat different issues. One is bundling, where the idea isn't always to offer the perfect bundle. The other is price discrimination, where they get you to self-select into a category that makes them more money.

Matthew said...

Dr. Tufte mentioned that even though we talk about firms changing their prices, they can still ultimately compete with anything that brings abnormal profits. Dr. Tufte suggested that firms could compete by raising quality. This is very true. Of course you have basic staples (example: potatoes) that have reached market penetration, but for most other items, it takes awhile to get to that point. When a company can differentiate themselves and give customer more perceived value, there is room for them. If enough people are complaining about cable then another company will realize the market potential and create a cable company with great service. Customers will go to whichever company better fits their needs and gives them more consumer surplus.

Dr. Tufte said...

Agreed. I think it's pretty hard to assert that competition doesn't help us get better stuff.